Download Test Bank for Analysis for Financial Management 13th Edition by Robert Higgins and more Exams Finance in PDF only on Docsity!
Test Bank for Analysis for Financial
Management 13th Edition
by Robert Higgins
Complete Chapter Solutions Manual
are included (Ch 1 to 9)
** Immediate Download
** Swift Response
** All Chapters included
** Even-Numbered Problems
** Cases Recommendations
** Excel solutions
1
Analysis for Financial Management, 13e
SUGGESTED ANSWERS TO EVEN-NUMBERED PROBLEMS
Chapter 1
- Management is either foolish or thinks its board is. Earning $100 million on a $5 billion equity investment is a return of 2 percent, which is below any reasonable cost of equity. As a board member, I would vote to cut management’s compensation, not raise it. I would also criticize them for apparently attempting to deceive the board.
- a. Cash rises $500,000; plant and equipment falls $300,000; equity rises $200,000. b. Net plant and equipment rises $80 million; Cash falls $32 million; Bank debt rises $48 million. c. Net plant and equipment rises $60 million; cash falls $60 million. d. Cash falls $40,000; Accounts payable falls $40,000. e. Cash falls $240,000; Owners’ equity falls by $240,000 (via an increase in Treasury stock). f. Cash rises $80,000; Inventory falls; Accrued taxes, Owners’ equity, and possibly other cost categories rise such that the algebraic sum equals $80,000. g. Accounts receivable rise $120,000. Other categories change as described in part f. h. Cash falls $50,000. Owners’ equity falls by $50,000 (via Retained earnings).
- a. R&E Supplies, Inc. Sources and Uses Statement 2018 – 2021 ($ thousands) Sources of cash: Decrease in cash and securities $ Increase in accounts payable 2, Increase in current portion long-term debt 40 Increase in accrued wages 13 Increase in retained earnings 537 Total $3, Uses of cash: Increase in accounts receivable $1, Increase in inventories 1, Increase in prepaid expenses 4 Increase in net fixed assets 159 Decrease in long-term debt 200 Total $3,
- a. Company A B C End-of-year cash balance $150^ million^ $30^ million^ $120^ million b. It appears that company C retired more debt than it issued, repurchased more stock than it issued, or some combination of the two. c. I’d prefer to own company A. A appears to be a growing company as evidenced by the sizable net cash used in investing activities, and its negative net cash flow from operations may well be due to increasing accounts receivable and inventories that naturally accompany sales growth. Company B appears not to be growing, so its negative net cash flows from operations are probably due to losses or to increasing receivables and inventories relative to sales, a trend denoting poor management of current assets. d. I don’t think there is necessarily any cause for concern. It appears company C is a mature, slow-growth company that is returning its unneeded operating cash flows to investors in the form of debt repayment, share repurchase, dividends, or some combination of these. This is a perfectly viable strategy in the absence of attractive investment opportunities.
- See suggested solutions to Excel problems at McGraw-Hill’s Connect or at www.mhhe.com/Higgins13e.
Chapter 2
- a. Price-to-earnings ratios are highly dependent on future growth expectations. I would expect the high-growth Alphabet to have a higher P/E ratio than the low- growth Union Pacific. b. The financial institution should have a higher debt-to-equity ratio because the liquid, relatively safe nature of its assets enables it to borrow more money at attractive rates. And in the case of banks, deposit insurance enables the institution to collect low-cost deposits. The principal asset of financial institutions tends to be relatively safe loans that generate relatively predictable income streams. The uncertain income stream of the high-tech company makes it less creditworthy, suggesting a lower debt-to-equity ratio, all else equal. c. The appliance manufacturer should have the higher profit margin because it adds more value to its product than a grocer does and hence can charge a higher markup over cost. d. The jewelry store should have the higher current ratio. Jewelry stores typically need to have a lot of expensive display inventory on hand and often offer time payment plans to customers. Online bookstores, on the other hand, typically carry little inventory and rely on credit card sales involving little accounts receivable.
- a. ROE will most likely fall. The numerator of the ratio, net income, will decline because the acquired company is losing money. Unless the acquiring firm’s equity declines due to the acquisition, a highly unlikely event, ROE will decline. b. This, however, is not important to the decision. This is another example of the timing problem. If the technology company has great promise, it may make complete sense to acquire the business even though it is currently losing money. The proper way to evaluate the acquisition is by estimating the target’s fair market value and acquiring it at a lower price. This is the topic of Chapter 9.
- Your colleague’s argument has a couple of holes in it. First, he has forgotten the timing problem. The investment has consequences over many years, and it is inappropriate to base the decision on only one year’s results. As will be discussed beginning in Chapter 7, the appropriate rate of return for evaluating investment opportunities is not the division’s accounting ROI but a rate that specifically incorporates the time value of money.
b. Insights: ● All of the profitability ratios are down. ROE, while still respectable, has fallen by almost half, and the profit margin is down by more than half. This suggests problems on the income statement. ● Leverage is up and liquidity is down. Liabilities now constitute over 70 percent of assets, and the current ratio has fallen almost 40 percent. ● Asset turnover has been reasonably steady, although the collection period has risen over 15 percent. The payables period has almost doubled, and at 66 days, appears quite long. ● R&E Supplies’ rapid growth causes a continuing need for external financing. Falling operating margins have exacerbated this need. The company appears to have met this need by reducing liquidity (days’ sales in cash is down from 21. days to 7.3) and by increasing trade financing. At the same time, long-term debt to equity has fallen. The company would probably be advised to replace some of its trade financing with a bank loan, part of which is longer-term. It also should rethink its pricing-growth strategy. One might argue that R&E has been “buying growth” by underpricing its product. 10.a. i. Liabilities-to-equity ratio = 200/300 = 0. ii. Times interest earned = EBIT/interest expense = 120/28 = 4. iii. Times burden covered = EBIT/[interest + principal repayment/(1 – tax rate)] = 120/[28 + 24/(1 – 0.40)] = 1. b. i. To fail to cover the existing interest payments, the times interest earned ratio has to fall below one. (4.29 – 1)/4.29 = 76.7%, or (120 – 28)/120 = 76.7% ii. To fail to cover the interest and sinking fund payment, the times burden covered ratio has to fall to below one. (1.76 – 1)/1.76 = 43.2%, or [120 – (28+24/(1 – 0.4))]/120 = 43.3% (The difference is due to rounding.) iii. To fail to cover interest, principal, and dividend payments we must further subtract the impact of dividends on EBIT. [120 – (28 + ((24 + 0.30 × 20)/(1 – 0.4))]/120 = (120 – 78)/120 = 35%
- A = Walmart. The low profit margin is characteristic of supermarkets or discount retailers. The collection period is low because as a retailer Walmart does not offer credit terms to its customers. Also, the relatively large difference between the current ratio and the acid test is indicative of the large amounts of inventory that Walmart carries.
B = Boeing. The biggest giveaway is that the inventory turnover is very low, indicative of Boeing’s long production process and relatively infrequent sales. The negative profitability reflects the difficulties Boeing experienced during this period after crashes of the 737 MAX. C = Facebook. The current ratio and the acid test are the same (and inventory turnover is not applicable), reflecting the fact that Facebook has little or no inventory. The high profitability ratios and price-to-earnings ratio are characteristic of a company that has a strong competitive position and for which investors have high expectations. D = Citigroup. The high debt ratio and low times interest earned are characteristic of financial firms. Also, as a financial firm, gross margin and inventory turnover are not applicable. E = McDonald’s. The very high inventory turnover is the clearest indicator of a fast- food restaurant. You can’t leave that food sitting around for too long. (McDonald’s had negative book equity during this period.) F = Apple. There isn’t one clear giveaway here, but the high profit margin is indicative of Apple’s premium product, the high price-to earnings ratio reflects strong investor expectations, and the high inventory turnover reflects the high demand for Apple’s products.
- a. Q1 Q2 Q3 Q Collection Period 27.0 27.0 27.0 27. Days Inventory Outstanding 92.8 320.6 455.6 23. Payables Period 18.0 36.0 36.0 6. b. Q1 Q2 Q3 Q Operating Cycle 119.8 347.6 482.6 50. Cash Conversion Cycle 101.8 311.6 446.6 44.
Chapter 3
- Historical analysis helps decide for which financial statement items a percent-of-sales forecast might be appropriate. For example, a stable trend in the collection period would tell you that, unless you expect changes in the management of the accounts receivable, future collection periods should continue along this trend.
- a. True. External funding required = Total assets – (Liabilities + Equity), so an increase in accounts receivable, an asset account, will increase external funding required; i.e., the additional accounts receivable will need to be financed. b. False. When executed properly, cash flow forecasts and pro forma financial statements should give the same estimate for external funding required. c. False. An annual forecast for 2022 showing no external funding required only assures the company that no cash shortfall is likely at the end of 2022. If the business has significant seasonality, cash shortfalls could still be likely at other times during 2022.
- a. If the collection period is 60 days, May cash receipts from March sales will equal half of March sales or $200,000. In addition, the company will receive cash from half of May sales, or $260,000. The total is $460,000. The May accounts receivable balance should be the last 60 days’ worth of credit sales. May credit sales were $260,000 and April’s were $325,000, thus the accounts receivable balance would be $585,000. b. With a 45 - day collection period, cash collected on May 1 is from credit sales made in mid-March, and collections on May 31 are from credit sales made in mid-April. Therefore, cash receipts from credit sales are from the period mid-March through mid-April, or (400,000/2 + 650,000/2)/2 = $262,500. Adding sales for cash of $260,000, the total is $522,500. The accounts receivable balance would be May’s credit sales and half of April’s credit sales, or 260,000 + 325,000/2 = $422,500.
- New equity equation: = C37 + D28. New net sales equation: = C19 + C19*D4.
- Westmark Cash Budget for First Three Months of 2022:
1 0 January February March Cash receipts: Sales for cash $120,000 $48,000 $48, Collections from credit sales 960,000 480,000 192, Total cash receipts 1,080,000 528,000 240, Cash disbursements: Payment for purchases 540,000 1,200,000 300, Wages 180,000 180,000 180, Interest payments 0 0 90, Principal payments 0 0 210, Dividends 0 0 300, Tax payments 0 180,000 0 Total cash disbursements 720,000 1,560,000 1,080, Net receipts (disbursements) 360,000 – 1,032,000 – 840, Determination of cash needs: Beginning cash 300,000 660,000 – 372, Net receipts (disbursements) 360,000 – 1,032,000 – 840, Ending cash 660,000 – 372,000 – 1,212, Minimum cash desired 150,000 150,000 150, Cash surplus (deficit) $510,000 – $522,000 – $1,362, Clearly, the treasurer had better concern himself with where to borrow money. Westmark will need over $1.3 million by the end of March.
1 2
- a. Toys- 4 - Kids 2022 Quarterly Pro Forma Forecast Assuming Level Production ($ thousands) Qtr 1 Qtr 2 Qtr 3 Qtr 4 Net sales $300 $375 $3,200 $5, Cost of sales 195 244 2,080 3, Gross profit 105 131 1,120 1, Operating expenses 560 560 560 560 Profit before tax (455) (429) 560 1, Income taxes (182) (172) 224 476 Profit after tax (273) (257) 336 714 Cash $200 $200 $200 $ Accounts receivable 225 281 2,400 3, Inventory 1,747 2,946 2,308 500 Current assets 2,172 3,427 4,908 4, Net plant & equipment 1,000 1,000 1,000 1, Total assets $3,172 $4,427 $5,908 $5, Accounts payable $222 $222 $222 $ Accrued taxes (182) (172) 224 476 Current liabilities 40 50 446 698 Long-term debt 400 400 400 400 Shareholders’ equity 2,727 2,470 2,806 3, Total liabilities & equity $3,167 $2,920 $3,652 $4, External financing required $5 $1,507 $2,256 $ b. Profits more than double, from $253,000 to $520,000. (Remember, this ignores the increase in interest expense due to increased borrowing.) c. Level production causes ending inventory to rise from $500,000 each quarter to a high of $2,946,000 in quarter 2. The external financing required jumps over
1 3 twofold, from $920,000 under seasonal production to $2,256,000 under level production. d. The company may be able to borrow the needed money, but the decision is not obvious. The maximum loan need of $2.3 million occurs in quarter 3. Possible collateral at that time includes $2.4 million in accounts receivable and $2.3 million in inventory. The accounts receivable are high quality collateral, but the inventory is not. The toy business is subject to severe fads, and there is no guarantee that finished goods inventory will find a buyer. From a lender’s perspective, the situation is more problematic in the second quarter. The loan need then is only $1. million, but accounts receivable are insignificant. The principal collateral in quarter 2 is $2.9 million of speculative inventory. Shifting to level production promises a major increase in profit. On the other side of the ledger, borrowing needs are much larger, and the company incurs serious obsolescence risks. The choice is not an easy one. A possible intermediate strategy is to move to quasi-level production, producing stable items for inventory early in the year and fad items for immediate sale later. This enables the firm to capture much of the benefit of level production while limiting obsolescence risk.
- See suggested solutions to Excel problems at McGraw-Hill’s Connect or at www.mhhe.com/Higgins13e.
1 5
- Although there are periodic ups and downs, there is a general upward trend in gross public equity issues for U.S. corporations in the last 35 years. This is not necessarily a contradiction to Figure 4.5. Figure 4.6 shows that U.S. companies are issuing more equity today than they did 35 years ago. Figure 4.5 shows that despite this pattern, U.S. companies are retiring more equity than they are issuing, and this difference is growing. This is a testament to the dynamism of the U.S. economy.
- a. Under Armour’s sustainable growth rates are 2009 2010 2011 2012 2013 Sustainable growth rate (%) 15.0 17.4 20.1 20.2 20. b. Under Armour’s challenge over this period was to manage its rapid growth rate. Actual growth exceeded sustainable growth by a significant margin in each of the five years. c. The company’s principal response was to increase its profit margin, by a total of some 27 percent over the five years. Also important was a 12 percent rise in financial leverage. As a consequence, Under Armour’s sustainable growth rate increased every year, except for 2013. d. We can answer these “what if” questions by substituting the assumed ratio value for the actual value in 2013. Under Armour’s revised sustainable growth rates are as follows: Profit Margin = 8.0% Sustainable growth = 22.8% Financial leverage = 2.4 times Sustainable growth = 25.2% Both changes occur Sustainable growth = 28.8%
- a. Stryker’s sustainable growth rates are 2009 2010 2011 2012 2013 Sustainable growth rate (%) 16.1 16.8 15.3 13.4 7. b. Stryker’s challenge over this period is that its actual growth rate is lower than its sustainable growth rate, so it needs to effectively manage increasing cash surpluses. c. Stryker increased its dividend payments over the period, from a dividend payout ratio of 17.9% in 2009 to 39.9% in 2013. The decreases in profit margin and asset turnover contribute to a falling sustainable growth rate, but note that decreases in these variables may not be desirable. Curiously, Stryker increased leverage over this period, which only raises its sustainable growth rate and adds to its cash surpluses.
1 6
- See suggested solutions to Excel problems at McGraw-Hill’s Connect or at www.mhhe.com/Higgins13e.
1 8 10.a. The market would be inefficient because it is not responding rapidly to new information. b. Buy the target’s stock immediately on the announcement. Sell in four days after it has risen and pocket a nice profit. c. If many investors pursued this strategy, the increased demand on announcement would cause the price to jump sharply immediately after the announcement. The price response would become efficient. d. This problem illustrates the statement quite clearly. People discover an inefficiency, and in the process of capitalizing on the inefficiency, they drive it away. e. This is not necessarily evidence of market inefficiency. If investors expect the bid to be followed by higher bids from other potential buyers, the market will rationally and efficiently drive the price above the initial bid.
- Earning high returns in an efficient market is like winning at roulette. In any random process, there will be winners and losers, and some winners might win big. Earning consistently high returns over time is also possible in an efficient market, just like a gambler on a lucky streak might win repeatedly at roulette. The relevant questions are whether the very high returns or the length of the winning streak is inconsistent with blind luck or not. The continued investment success of Warren Buffett and his associated value investors does pose a challenge to market efficiency. The argument that this success is just luck stretches credulity. A more likely explanation is that high intelligence, extreme emotional discipline, and driven dedication do enable some people to earn superior market returns. At the same time, evidence tells us that these individuals are extremely few and far between, and that it is virtually impossible to identify these individuals with any reliability. It should also be noted that Warren Buffett is not a passive stock picker, that much like a private equity firm, Berkshire Hathaway, adds considerable value to acquired companies via changes in operational, management, incentive, and governance practices. 14.a. In Strategy 1, the net cost in dollars is €5,000,000/0.89 = $5,617,978. In Strategy 2, Kansas Corp. exercises its option to exchange at 0.88 €/$ for a cost of €5,000,000/0.88 = $5,681,818. Including the cost of the option, the net cost is $5,781,818. b. In Strategy 1, the net cost in dollars is again €5,000,000/0.89 = $5,617,978. In Strategy 2, Kansas Corp. allows its option to expire and exchanges at the spot rate of 0.95 €/$ for a cost of €5,000,000/0.95 = $5,263,158. Including the cost of the option, the net cost is $5,363,158.
1 9 c. Strategy 1 allows Kansas to lock in an exact cost without paying a premium up front. Strategy 2 requires a premium payment, but Kansas retains the possibility of having a much lower net dollar cost if the dollar strengthens enough relative to the euro. The correct strategy for Kansas depends on its risk tolerance, its expectations for exchange rate movements, and its cash availability. 16.a. This is a call option. You have the option to buy. b. The value of the option per share is $23.82. You own 1,000 options, so in total they are worth $23,820. c. $8.40 × 1,000 options = $8,400. There is a much better chance TWTR stock will rise to high levels in three years than in six months. d. $13.35 × 1,000 options = $13,350. The more volatile TWTR stock, the more likely it will rise to high levels during the life of the option.
